The Collapse of Hih – Solvency and Audit Risk

Topics: Auditing, Auditor's report, Insurance Pages: 4 (1438 words) Published: July 19, 2006
The Collapse of HIH – Solvency and Audit Risk
Following the collapse of HIH, considerable debate, comment and speculation have arisen regarding whether and at what point HIH became insolvent. When a company is close to insolvency, the risk associated with auditing that company is considerably higher than for one that is solvent. This report investigates methods of determining insolvency, the roles of directors and auditors, and the level of audit risk associated with HIH prior to its collapse. There is general agreement that the concept of solvency relates to having the capacity to meet debts as they fall due. An insurance company is solvent if it is able to fulfil its obligations under all contracts at any time (or at least under most circumstances). However, assessing solvency can be a challenge, as accurate estimates of the liabilities at the balance date may be difficult to determine. Analysis of company solvency can be made from two indications: financial indications and non-financial indications. Financial indications are used to assess commercial insolvency – the company being unable to pay all its debts as and when they become due. Non-financial indications are used to assess regulatory insolvency, which occurs when the company breaks the requirements imposed by legislation, supervising regulations and other laws. Regulatory insolvency can lead to commercial insolvency . Financial ratios, such as debt to asset ratio, current ratio and ratios calculated from the cash-flow statement can be used to determine commercial solvency, however care must be taken to ensure that that appropriate figures are used in the calculation. The HIH debt to asset ratio was 0.89 if the figures in financial reports were used; however if the PPE, deferred acquisition costs, intangibles and future tax benefits were disregarded, the ratio would be 1.01 – a warning sign of insolvency! This ratio indicates a major long-term under-provisioning situation. Operational indicators, such...

References: Auditing and Assurance Standards (AUS), available online at http://www.auasb.gov.au/standards.htm
Corporations Law (2001)
Dean et al. (2001), "Corporate Groups and Cross-Guarantee Financing", Charter, October
Gay and Simnet (2005), Auditing and Assurance Services in Australia, McGraw Hill Irwin
HIH Royal Commission (2003), Report of the HIH Royal Commission, Commonwealth of Australia, April
HIH Royal Commission (2003), "The Failure of HIH Insurance", A Corporate Collapse and its lessons, Volume 1, Hon Justice Owen, 4 April
IAIS Subcommittee on Solvency and Actuarial Issues (2000), Issues Paper, Final Version, 15 March
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